You know who you are. Every headline about U.S. employment gets you, whether it’s statistically significant or not. You worry how Europe will stay together under a common currency and how it’s going to get out of its current fiscal mess, especially given the growth outlook. The only bright spots in the world, the emerging markets, are clearly slowing down in your view. It is in the data everywhere, from Brazil, to China, to Korea, to India and beyond. At the beginning of the year, it was all looking so promising. And now, everything looks dusty and dour again, but I am here to get you out of your funk.
My job today is to give you worrywarts some lumbar injections to help you rebuild a bit of your backbone. What you see today as a negative is probably the biggest positive for the market, longer term. What is that, you ask? It is the repudiation of austerity in Europe.
Ever since the financial crisis began, it was clear that after the necessary adjustments took place, the U.S. economy would eventually climb out of its hole thanks to both monetary and fiscal support on a turbocharged basis. The developments in the U.S. economy over the last few years—the most recent tepid employment report notwithstanding—are actually working out exactly according to plan. Despite their early fumbles and jarring missteps, U.S. policymakers implemented what needed to be done. In a few decades, when we write the economic history of the U.S. for the first decade of the century, I believe it will be cited as the best era of policymaking in history (OK…that may be a bit of hyperbole).
Alas, nothing of the sort will be written about European policymaking. Due to their unfortunate history—wars, tribalism, etc., and the curse of a common currency at absolutely the worst time in their recent history—European policymakers have fumbled at every step.
First, they didn’t worry about their banks, which was silly because the banks, not the markets, were the primary financiers of the growth of sovereign and corporate debt over the last two decades. In their view, they needed no Troubled Asset Relief Program (TARP), no regimented stress testing and no forced raising of capital. Europeans did not follow our lead despite the fact that their banks were even more leveraged and had worse credit quality than their U.S. counterparts. Then, to add fuel to the fire of despair, when the sovereign crisis began to take center stage, they all coalesced around a German-dictated plan for continent-wide austerity.
After the fall of the Berlin Wall, Germany restructured its economy on the back of massive exports to the European periphery and has been the biggest beneficiary of the common currency. At a time when they should have been playing the part of a large, restructured economy which supported growth and restructuring everywhere else in the periphery, they were hell bent on preserving their economic advantage. And to make matters worse, they forced the European Central Bank (ECB) to stick to their economic doctrine.
Mr. Market, I am happy to report that both of these policies have been finally, and rightly, reversed. First, the ECB started its Long-Term Refinancing Operations (LTRO) program. Its effect may be fading, but the Rubicon has been crossed on that front and more plans will be forthcoming. More importantly, in country after country, fiscal austerity plans are being repudiated. And none too late, in my view. Whatever the odds were for us to put the financial crisis behind us, they just went up meaningfully. If there is policymaking follow-up to the French and Greek elections, there is hope for the world after all. Look…it didn’t feel like the LTROs were going to change the world, but they did. And while they are likely to be slower to develop, the magnitude of the impact of the political developments is likely to be even greater than that achieved through the LTROs.
So, yes, feel blue today if it catches your fancy. But the world just changed and it’s all for the better.